The Five C's of Credit

What ratio of leverage is probably too much?

• Leverage: money borrowed to finance operations Probably around 5:1 is too much leverage.

Consumer Financial Protection Bureau (CFPB)

An independent bureau within the Federal Reserve that helps consumers make financial decisions. • They recommend a DTI of 43% or less for borrower's seeking to obtain mortgages and comfortably afford monthly payments.

FICO credit score

a credit score method that reflects a borrower's credit risk based on a snapshot of their credit report at a particular point in time KEY • Very Bad: 300-560 • Bad: 560-650 • Neutral: 650-700 • Good: 700-750 • Excellent: 750-850

margin call

a demand by a broker for immediate repayment of a loan • The loans are typically for investors to purchase stocks purchased on margin.

working capital

a measure of a firm's average amount of short-term cash on hand; the difference between current assets and current liabilities

Quick Ratio (Acid Test)

a measure of liquidity that doesn't account for inventory. This measure is typically used for businesses with high inventory turnover rates. • (Current Assets - Inventory) / Current Liabilities

coverage ratio

a metric intended to measure a company's ability to service its debt and meet its financial obligations, such as interest payments or dividends • EBIT / Interest Expenses

Debt to Income Ratio (DTI)

a person's monthly debt as compared to their gross monthly income; measures how much financial burden a mortgage payment would place on a household • monthly debt / monthly income • 35% or less is preferable for new financing

net worth

a person's total financial value, determined by total assets minus total liabilities

Current Ratio

a ratio that measures short term liquidity • current assets / current liabilities

lien

a right specified in an agreement or contract for a lender to keep possession of property belonging to the borrower until a debt owed by that person is discharged • meant to hedge defaults • Examples of collateral include automobiles, houses, etc.

credit history

a summary of a person's borrowing and repayment history • conveyed by credit reports

Certificate of Deposit (CD)

an interest-earning deposit that requires the funds to remain deposited for a fixed term. • Withdrawal of the funds before the term expires results in a financial penalty.

owner occupied commercial real estate

any non-farm, non-residential properties for which the primary cash flow is derived from the ongoing operations and activities conducted by the party or an affiliate of the party, who owns the property. • EX: hospitals, golf courses, etc.

secured debt

debt securities that are guaranteed by collateral • Loans can be secured with collateral as well. These loans often offer lower interest rates and better terms.

Private Mortgage Insurance (PMI)

insurance provided by a private carrier that protects a lender against a loss in the event of a foreclosure and deficiency • used in mortgages

credit reports

reports by credit bureaus that detail how a person has used credit in the past, including their borrowing and repayment history • assigns a score which lenders use to decide whether to lend FEATURES • amount borrowed, time of repayment, bankruptcies, around 7-10 years of history showed, FICO score MAJOR CREDIT BUREAUS • Experian, TransUnion, Equifax, Vantage

marketable securities

short-term, low-risk investments that can be easily sold and converted to cash

cash flow coverage ratio

the ratio of a company's operating cash flow to total debt

When is it ideal to buy property?

• When the economy experiences low interest rates. • When the borrower has sufficient capital for favorable down payments. • When the value of real estate is low and expected to appreciate. • Some investors with a long investment horizon may consider placing their capital in index funds or ETF's for potential growth at the risk of loss of capital.

Which of the five C's of credit is considered as most important to lenders?

• character (credit history) - The borrower's credit history. • capacity - The applicant's debt-to-income ratio [individual] or cash flow coverage ratio [commercial].

How does the size of a mortgage loan's down payment affect its interest rates?

The higher the down payment, the more favorable the terms and rates of the loan will be. • The Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) typically require a down payment of 3.5% or more. • A down payment of 20% or more helps the borrow avoid the requirement of having to purchase Private Mortgage Insurance (PMI).

What are the five C's of credit used to convey the creditworthiness of potential borrowers?

• character (credit history) - The borrower's credit history. • capacity - The applicant's debt-to-income ratio [individual] or cash flow coverage ratio [commercial]. • capital - The total amount of money the borrower possesses. • collateral - The asset backing or acting as the security for a loan. • conditions - The purpose, size, and interest rates of the loan.

What features about the borrower themselves would lenders consider when deciding to authorize a loan?

• debt/income, credit score. • length of time applicant has been employed. • job industry, career stability/growth projections • state of the economy. • intentions and purpose of the borrower wanting a loan.

How can a borrower's debt to income ratio be improved?

• increase salary/wages • decrease debt by paying down balances • refinancing debt for lower interest rates